East Asia performed economic `miracle' by catching up

Why do some countries get rich when others don't? If you think about it, almost nothing else matters in economics. Alas, it is one of those elementary and fascinating questions to which economists usually mumble inadequate answers. If we knew, it would all be easy: put in the right conditions and everyone would be rich. Instead, economists have focused on more arcane econometric equations that create elaborate theories on things you really do not want to know.

But there is a small school of economists who try to answer the really difficult questions, even if their answers have to be hedged with qualifications. Two brands of inquiry are attracting much practical attention. One is whether there is something special about the rapid growth of East Asian countries; the other, to what extent does closer economic integration between apparently similar developed countries boost their collective growth.

Examination of the first has been spurred by the explosion of growth in South-east Asia. Singapore and Hong Kong (seen as a separate entity from China) have achieved the income per head typical of European and North American nations - both have a higher income per head than the UK. While developing countries lifted their economic performance in the past 15 years, Asia has massively outperformed the rest. Some indication of this out-performance is shown in the graph on the left, taken from the new annual report of the IMF. Not only is the region producing rather more even growth, but the range of 6-10 per cent is outstanding by any criterion.

Gradually a body of work is being put together to explain this out-performance. The overall message is that this is not a miracle but can be explained mostly in terms of catch-up. East Asia has created a business-friendly environment which welcomes foreign investment. We live in an age where information can cross national boundaries in a few moments and this investment transfers not just money but brings know-how: know-how to manufacture in the first instance but subsequently how to market and develop new products. But the first phase of growth in East Asia has been driven by low wages, which has combined with technology transfer to enable the region to produce western quality goods at much lower prices.

After a while, the very success pushes up wage rates so that labour costs in, say, Korea, are now higher than in the UK. Success in the middle market forces countries further upmarket, a transition they find difficult to achieve. Japan, the classic case of catch-up, has hit a glass ceiling: it has had the slowest growth rate over the last five years of any of the Group of Seven.

This leads to the second question. Once countries are no longer catching up, how might they improve their performance? This is a practical question for Europe at the moment for it seems that the better performance of western Europe since the end of the war has been closely associated with closer economic integration. Take for example Germany.

The second graph shows what might have happened to German growth had it continued on the slow and steady upward path established in the second half of the last century, and in particular how growth leaps upwards after 1950. Similar results come from other western European countries, which suggest that growth in international trade enabled a step-change in economic performance.

Both world wars saw a sudden dip in output, but after the first war growth resumed at the pre-war rate, whereas it leapt upwards after the second. But in the 1920s there was relatively little trade liberalisation (and some reversal in the 1930s), while in the 1950s and 1960s trade was progressively freed.

These two issues - what makes countries grow and how international trade assists growth - will be discussed today at a meeting organised by the Centre for Economic Policy Research, starting with a presentation by Professor Dan Ben-David of Tel-Aviv University. The core of his argument is two-fold. One is that the world technology is increasing productivity at a rate which changes over time: from near-zero growth for centuries to around 2 per cent over the last 100 years. The other is that countries can move themselves from technical laggards to the forefront of technology with the right policies.

So if you are a long way behind you do not particularly need to invent anything yourself. You simply apply other people's inventions and you will catch up with the leaders. But to do so you need to apply appropriate policies.

But what if you are at the frontier, if you are, say, Switzerland, with the highest standard of living in the world? I suppose Professor Ben-David's response would be to press on with trade liberalisation and become even more specialised. That would seem to be common sense. I suppose too that it is important to avoid waste: to fine-tune an economy so that scare capital and scarce human skills are not blown on projects which do not yield an adequate return.

At the end of the day, though, if the world's technology is delivering only 2 per cent growth and you are at the forefront of that technology, you have to learn to live with that sort of advance.

Indeed, it is worse than that. Much of the fruits of that additional productivity will be mopped up by adverse demographic factors. If there are fewer people of working age relative to children and the old, workers will have to accept lower living standards than otherwise would be the case, to support people not at work. It is interesting that real take- home pay has hardly risen in France and Germany over the last 15 years despite good growth in productivity.

I would add a further element. GNP per head, the usual measure of economic performance, is itself flawed. For example, if there is an increase in car crime and people as a result have to put alarms in their cars, that shows up as growth in GDP. But living standards are not higher as a result of the increase in crime; in fact they are lower. So any rise in GNP that is the result of increased disruption in society - more legal fees, higher bureaucratic costs -should be taken with the caution it deserves.